Incubating the new energy economy

ALBANY, NY (CBS.MW) -- Shares of stocks involved in fuel cell technology have experienced a voltage spike since the beginning of the year.

Plug Power and parent Mechanical Technology, which traded stoically in the 20s in the last millenium, have tripled and quadrupled in recent weeks.

"It's as if the calendar turned over and people just fell in love with this whole new group, and Plug Power first," said Mechanical Technology's chairman and CEO George McNamee.

The buzz around fuel cells is that they're cleaner, more reliable, and will eventually be cheaper alternatives to grid-produced electricity. Widespread deregulation combined with a potentially global market have turned investors on to what they see as the hot new tech stocks. But is it a speculative or grounded play?

Electric bull

Hugh Holman, who follows the power technology sector for CIBC World Markets, is one of the fledgling industry's most vocal bulls.

"I think this is one of the most important transformations that's going to occur in the first 10 or 20 years in the new century," he said. Holman dubbed Mechanical Technology "the CMGI of energy technology," referring to the wildly successful Internet holding company.

Mechanical Technology
MKTY, +1.31%
known as MTI, is up more than 300 percent since the first of the year. It's transforming its core business from making test and measurement instruments into incubating new energy companies.

In February MTI reported a fiscal first quarter loss of $1.78 million or 15 cents a share, versus $1.6 million or 14 cents in the year-ago period.

The firm began doing fuel cell research 10 years ago and spun off residential fuel cell developer Plug Power
PLUG, -4.58%
in a joint venture with Detroit's DTE Energy
DTE, +0.08%
in 1997. Shares of Plug Power are up more than 400 percent since the beginning of the year. Plug went public in October 1999 at $15 a share and now carries a market value of $4.73 billion.

Mechanical Technology now trades at 84 with a market cap of $974 million. MTI holds a 32 percent stake in Plug and a 16 percent stake in SatCon Technology
SATC, +15.38%
a Cambridge, Mass.-based power components company. MTI announced a 3-for-1 stock split in early March 2000 and split its stock 3-for-2 in April 1999.

All of this is heady stuff for a holding company whose primary high flying offspring is just beginning to field test its products.

But McNamee is confident the firms are onto a long-term trend. "We think the residential power opportunity can keep Plug Power busy for a generation," he said.

Old meets new

Fuel cells are battery-like devices that generate power through electrochemical means instead of combustion. There are different kinds of fuel cells that operate at varying temperatures, but the kind that MTI and Plug Power focus on is the home-friendly proton exchange membrane model or PEM.

George McNamee, CEO Mechanical Technology

The appliance is currently the size of a refrigerator, but McNamee said he expects to reduce it to the size of a dishwasher by the time it's commercially available for about $3,000 to $5,000 in 2003.

The device contains a fuel processor that converts natural gas into hydrogen, the fuel cell to convert hydrogen into electricity, and power conditioning equipment to convert the electricity into high quality AC power. The byproducts are water and a small amount of carbon dioxide, according to McNamee.

McNamee expects consumers to embrace the technology in part to gain reliability. Customers will no longer tolerate periodic outages as more people wire themselves with so-called smart houses that have high end computer and entertainment systems to support, he said. The conventional electric grid wasn't designed to deliver the quality that a "24-by-seven economy" requires.

"Nobody wants to call the serviceman to have his home system rebooted," he said. "Even a voltage sag of a few percent can affect sensitive digital controls."

Assessing the competition

While Mechanical Technology expects Plug Power to have many competitors emerge in the burgeoning residential space, it counts Canadian company Ballard Power Systems
BLDP, +1.65%
as its closest rival for now.

Up till now, Ballard has focused on the automotive market. Requirements that at least some percentage of U.S. automobiles be non-polluting by 2010 are expected to bolster that market.

But the British Columbia-based firm has also announced plans for residential fuel cells in Japan, and McNamee doesn't discount the possibility of a move into the North American market somewhere down the line. Ford
F, +0.77%
and Daimler Chrysler
dcx
own majority stakes in Ballard.

FuelCell Energy
FCL, +0.00%
is another player that, like Plug, has received grants from the Department of Energy. The latest round of funding to develop a hybrid fuel cell/turbine power plant sent the stock soaring in early March, but FuelCell's business in central generation plants doesn't interfere with MTI's mission, said McNamee.

He expects Plug to be the first to market with fuel cells designed for home power with the help of a key marketing partner, GE Power Systems
GE, +0.54%
GE has a12.4 percent stake in Plug.

"It'll be very hard for competitors to replicate that combination of brand, distribution, service," said McNamee.

"We think Plug's got a lot of advantages and its game plan is to run faster than anybody else and maintain the leading market share in what we all think is going to be an enormous market."

McNamee confirmed that MTI is looking for new additions to its fuel cell family, but declined to name names. While he described the military market as "interesting," Plug hasn't pursued it yet, he said.

Holman, currently the only analyst following MTI, said the firm's holding company model faces few direct challengers. "What you will find is that there are lots of large Fortune 100 companies that have investments in energy technologies, but on a very selected basis," he said, naming Enron
ENE, +1.58%
United Technologies
UTX, +1.05%
and Avista
"
as examples.

Motley fuels?

As Plug moves closer to its goal of mass marketing fuel cells through distributors and ultimately big box retailers, the big question is whether it can ramp up manufacturing fast enough. A second risk McNamee cited is whether GE can develop the large global market that it's set its sights on.

Holman said he believes Plug can overcome technical production glitches as they arise, but he cites pricing and consumer demand as significant variables. However fickle market acceptance can be, he thinks consumers will make the switch to so-called green power -- even if it's at a premium -- based on environmental benefits, high quality and independence from local utilities.

Another risk is the pace of deregulation and whether the restructured power industry allows for largescale distributed generation, said Holman.

Despite the uncertainties, Holman advised treating the holdings not as a gamble but as an emerging technology.

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